Chainalysis report: In 2019, mining pools injected 700,000 bitcoins into exchanges, and competition among mining pools became increasingly fierce

• Miners are an integral part of the digital asset market. Their competition verifies BTC transactions, and their mining income is the source of the BTC sold. Currently, BTC mining is mainly carried out through professional mining pools, which allow miners to deploy resources together.

• By the beginning of 2020, the number of mining pools had dropped to 11. However, no single mining pool has yet controlled the absolute hash rate, and the competition among the top mining pools in 2019 has become more intense than in 2017 and 2018, which also shows that the BTC network is still secure.

• In 2019, mining pools provided 28% of BTC flowing into exchanges that did not come from other exchanges, making them the most important and reliable source of non-exchange BTC to exchanges.

• However, mining pools are not the only source of BTC entering the market. Currently, there are more BTC held in personal wallets for investment than the amount of BTC to be mined; and after the halving, the importance of these investment-type BTCs being transferred to exchanges will become increasingly greater.

• In 2019, mining pools sent 700,000 BTC to all exchanges, and 10 major exchanges received 77% of them. The main exchange receiving BTC was Huobi, accounting for 29%; followed by OKEx, accounting for 12%. In addition to these two exchanges, exchanges also seem to be competing for the BTC of mining pools.

This range of work makes miners an integral part of the digital asset market. Their competition verifies the permanence of BTC transactions and prevents double spending. This replaces the need to go through a central authority to conduct transactions, and they are the source of new BTC to be sold. This raises questions about the power of miners. How fierce is the competition between miners, and how do new BTC enter the market?

Using Chainalysis data, we can answer these questions quantitatively. Mining pools, which coordinate the resources of individual miners, are key to the answer. Mining pools dominate BTC mining, but there is huge competition between mining pools. This shows that the network is and will be secure.

New BTC tends to enter the market through two major exchanges, Huobi and OKEx, but it seems that other exchanges are also quite competitive for mining pool BTC. Since mining pools require fiat currency to pay fees, exchanges related to China dominate, which is the easiest place to exchange BTC for RMB (although not directly), which also provides further evidence that miners are mainly located in China.

The rise of mining pools

Bitcoin mining is now done primarily through professional mining pools. Prior to 2012, Bitcoin was mined primarily by anonymous individuals. This changed in 2013, with most mining being done through mining pools. Mining pools enable individual miners to collectively deploy their resources to mine Bitcoin more frequently in a pool and share the proceeds. Mining pools can also offer cloud mining services, where clients pay for mining on their behalf.

As the use of specialized ASIC miners continues to increase, the transfer of independent miners to mining pools is also ongoing. Without ASICs, mining will become an impossible task, and the price will rise from tens of dollars per BTC to hundreds of dollars. In 2019, well-known mining pools received 92% of mining rewards, which is the lowest level since 2016, indicating that some miners have recently started independent mining, or mining pools are seeking stronger privacy.

Competition between mining pools

By early 2020, the number of prominent BTC mining pools had dropped to 11 from a peak of 30 in March 2017. This decline coincided with a period of relatively low BTC prices and a doubling of total hash rate in the first quarter of 2019. Lower fiat currency rewards and the increased resources required to earn rewards may have led to the consolidation of mining resources.

If there are fewer mining pools, it increases the risk that a single pool can control the hash rate share, allowing it to disrupt the entire network. However, since 2016, the largest mining pool has never exceeded 33% of the total hash rate at any time. In 2019, the largest mining pool accounted for 16.8% of the total hash rate, followed by the second and third largest mining pools, with hash rates of 12.9% and 12.8% respectively. This shows that miners have distributed their hash rate among the various pools, so that there is no dominant mining pool in terms of hash rate, although the top four mining pools do control the majority of the hash rate.

Compared with 2017 and 2018, the competition among the top mining pools in 2019 was more intense. In 2019, on average, the largest mining pool only stayed in the first place for 4 months, and rotated with other mining pools such as BTC.COM, F2Pool, and Poolin in the top four positions. In contrast, the largest mining pools in 2017, such as Antpool.com and BTC.com, stayed in their corresponding rankings for a whole year. The competition among mining pools outside the top two is always very fierce, and their rankings will rise and fall every one or two months.

Therefore, although there are relatively few mining pools, no one mining pool dominates, and there is strong competition among them. This also shows that BTC transactions are currently complete and undisturbed. It also reveals an important aspect of decentralization, namely centralization with a certain incentive nature. For example, miners can increase their total rewards by joining a mining pool. However, the BTC protocol is open, which means that miners can switch mining pools, so centralization does not mean the concentration of power. That is, the power of mining decisions can be centralized in other aspects: mining pools can cooperate properly; Bitmain produces most of the mining hardware. In addition, we need further research to understand how the miners' hash rate is centralized, not just how centralized they join mining pools.

What is the role of the new BTC in the market?

In addition to their role of validating BTC transactions, miners are also a key source of new BTC. Since 2018, miners have received a total of $12.3 billion worth of BTC at the time of mining, 94% of which came from mining pools.

Mining pools don’t hold BTC for long after receiving it. Since 2017, the average time that mining pools have held BTC has been 67 days at most. This peak occurred in July 2018, as mining pools held BTC for a long time after the price rebounded in late 2017. As prices fell after July 2018, mining pools sent out the BTC they had been holding, even as prices rose, and this trend continued even as BTC prices grew in 2019. This shows two things: first, mining pools are allocating more and more BTC to miners; second, their own BTC inventory levels are low and not growing.

The main reason why mining pools and miners cannot hold their BTC for long is that they need to sell their BTC in exchange for fiat currency to cover costs such as the electricity required to carry out mining. Therefore, miners send their BTC to exchanges, or to brokers, who usually sell them on exchanges in exchange for fiat currency.

Almost 90% of all BTC flowing into exchanges comes from other exchanges as traders seek arbitrage opportunities. But this simply moves BTC between different markets and does not change the total amount of BTC available for buying and selling, so it does not fundamentally affect the price.

Conversely, when miners send BTC to exchanges, they are also injecting liquidity into the market. This increases the supply of BTC on the market, which may reduce the price of BTC. In addition to BTC obtained from other exchanges, mining pools are the most important source of BTC inflows to exchanges, followed by custodial wallets and business services. Since 2017, 28% of the BTC that exchanges have obtained from services has come from mining pools (excluding inflows from other exchanges).

However, mining pools are not the only source of new BTC entering the market. Because there are more BTC left in personal wallets for investment than there are BTC to be mined. Therefore, if the BTC used for investment flows into exchanges, market liquidity may increase significantly. The BTC price drop in mid-March 2020 seems to be in line with this situation. This type of BTC can also make up for the loss of available BTC due to the BTC halving, which will reduce the reward for mining a new block from 12.5BTC to 6.25BTC.

Once we identify BTC flowing to exchanges, we identify the ultimate service (such as a mining pool) from which the BTC value originated. Rather than being transferred directly from one service to another via direct transfers, the value may have been (and most of the time is) passed through intermediate addresses between services. These intermediate addresses are often controlled by unknown private entities, such as miners who receive BTC from mining pools and then send it to exchanges, or to exchange OTC brokers. That is, we look at the indirect exposure of exchanges to mining pools through any number of transfers between unknown entities such as miners or brokers, and compare the analysis of direct exposure, which provides us with a more comprehensive understanding of the operation of the entire network market.

As a whole, mining pools sent BTC to 415 different exchanges in 2019, with only 2 mining pools sending exclusively to one exchange. Despite the large number of exchanges receiving BTC, 10 major exchanges received 77% of the 700,000 BTC mined by mining pools in 2019. Huobi was the main recipient, accounting for 29%, followed by OKEx at 12%.

On average, at any given time, the exchange that received the most BTC from the mining pool received only 25% of the total BTC that the exchange received from the mining pool. The top 4 exchanges received 54% on average. Therefore, it seems that mining pools tend to concentrate on sending BTC to certain exchanges.

However, with the exception of Huobi, which has maintained its top ranking throughout 2019 and is often the main destination for new BTC inflows, it seems that the competition among other exchanges for BTC will be more intense. Few exchanges other than the top few exchanges have been able to maintain their rankings steadily. 2017 was a particularly turbulent year for exchange rankings. Miners sent BTC to Korean exchanges in order to profit from their high BTC prices. OKEx's popularity soared that year, and despite the closure of BTCC, miners welcomed another exchange - Binance.

Since mining pools require fiat currency to pay fees, the dominance of China-related exchanges such as Huobi and OKEx provides evidence that miners are mainly located in China. From these exchanges, it is relatively convenient to convert BTC into RMB (although it cannot be done directly). This also shows that these exchanges are the main liquidity providers in the BTC market because they frequently supply new BTC.

However, the level of competition outside of the top two exchanges also suggests that other exchanges are eager to attract the liquidity brought by new BTC, so they may actively seek to cooperate with miners. When the price of BTC on exchanges continues to rise, miners also seem to seize the arbitrage opportunity, as has happened in South Korea before.

Mining is often viewed as a mysterious force in digital currencies, perhaps because it is a unique quality of the asset class. However, as this report demonstrates, Bitcoin mining also appears to be a rational behavior, as miners make decisions that maximize their rewards in the face of competition, and in doing so, ensure the security of the network, as Satoshi designed it.

Multi-currency mining

BTC mining vs BCH mining: Reflections on price perception

Mining pools don’t just mine one cryptocurrency. It’s common for mining pools to mine both BTC and BCH because they are mined via the same algorithm, SHA-256. This allows the mining hardware to be optimized for the algorithm, allowing the pool to switch between mining either coin. Mining pools also mine Ethereum, Litecoin, and other tokens, but there’s no way to switch dedicated hardware between them.

In 2019, 59% of the total pool hashrate was generated by pools mining both BTC and BCH. Between the two cryptocurrencies, 95% of pool hashrate in 2019 was dedicated to BTC, up from 91% in 2018. Therefore, most pool hashrate occurs in pools that switch between the two cryptocurrencies, but the vast majority of this hashrate is dedicated to BTC.

BTC was worth between 16 and 39 BCH in 2019, so overall it was more profitable to mine BTC, so it attracted the majority of the hashrate. However, mining pools do switch some hashrate as the exchange rate changes. There is generally a positive correlation between the percentage change in BCH price relative to BTC price and the percentage change in BCH hashrate relative to BTC hashrate. Therefore, some mining pools do switch hashrate when the exchange rate changes, and some actually switch automatically.

We don't expect a perfect correlation between the two. It takes time to mine and sell: hours to days, depending on the share of hashrate. Therefore, the degree to which the hashrate distribution is switched reflects the pool's view on the short-term price of the two assets. If the exchange rate changes, but the hashrate does not, it means that the pool believes that the exchange rate will return to normal in the future.